Wednesday, January 22, 2014

Wealth inequality: slightly exaggerated

Twitter is a-twitter with the news: Just 85 human beings hold as much wealth as the poorest 3.5 billion combined. That statistic comes from a new Oxfam study on global wealth inequality.

Global wealth inequality is a big problem, of course, and has probably gotten bigger (or, as Richard Ash points out in the comments, stayed the same). But there are at least two problems with the "85 = 3.5 billion" statistic that cause it to exaggerate the problem.

The first is that the number doesn't control for age. Young people, unless they inherit a lot of wealth, can be expected not to start out with a lot of assets. As they grow older and work and save, they build up more. Thus, a lot of wealth inequality comes from the life cycle of spending and saving.

Think of a young person who just went to college, or just started a small business or farm (in a poor country, the latter two are much more likely). That person will tend to have more debt than assets, since the college education, the business, or the farm won't be valued yet. But those assets are real, even if they don't get counted in the official statistics. Eventually they will produce wealth. When we think of people with negative net worth, we imagine people drowning in medical debt or underwater mortgages or spiraling credit card bills - and of course there are lots of those people too. But many people borrow to invest, and that makes them look poor in terms of wealth, even when they aren't really poor.

You may ask: How big of a difference could that really make? Well, I'm not sure. There are a lot of young people in the world. In poor countries, a lot of people own farms and small shops. It probably doesn't change the overall pattern, but it will tend to make the numbers less eye-popping.

The second problem is that the numbers are all in U.S. dollars, not adjusted for purchasing power parity. In most poor countries, prices are much lower than in rich countries; thus, saving $100 there might be like saving $300 here in America (though it will cost a lot for the poor-country people to take a vacation in America).

If any of you out there have age-matched, PPP-adjusted wealth distribution data, I'd love to see it. I looked, but couldn't find it.

So buck up, everyone - wealth inequality is bad, but it's not quite as bad as the reports you hear. And remember, income has been growing strongly for the global middle class and most of the global poor. That is good news.

I dont know if you get Noah's point. Let us suppose that out of those 3.5 billion people 5 million are people with debts (negative wealth) and next 500 billion are with positive wealth that just offsets the negative wealth so the average is 0

Now you may be a young student without any debt who just recieved $500 check for his summer part time work. Since you have $500 positive wealth you are now richer then 1 billion people combined. This number sounds impressive but it doesn't tell you that much.

I suspect even after the adjustments you suggest there is an eye-popping amount of wealth inequality in the world. On your demographic point, see Table 4 from the SCF: http://www.federalreserve.gov/Pubs/Bulletin/2012/articles/scf/scf.htm#networth. This does not have net worth dispersion within the each age group but the gap between the mean and the median is driven by the right skew. Sure there are life-cycle differences but inheritances and family businesses play a role in the top of the wealth distribution.

I suppose there are ways that the wealth inequality estimate could be an understatement too. With taxes, there is an incentive to underreport wealth too.

" gap between the mean and the median is driven by the right skew."This is what Noah needs to realize.

In some sense, everything is OK within the 99%.

The problem is that the 0.1% is robbing the 99% blind. That is the only problem. The problem is a very, very small number of obscenely rich people.

I realize that this is counterintuitive for people trained in economics, who are trained to believe that the activities of a tiny number of people can't possibly matter. But it is the world we live in today.

But the obvious problem with that is that there is a non-trivial difference between a society in which the younger generation owes individual private debts to the older generation and a society in which the younger generation services collective social obligations to the older generation through, e.g. public health care and state pensions.

The former is a world in which the young generation will be compliant, servile and politically and economically disenfranchised, because they are burdened with individual obligations, and default on those obligations is an idiosyncratic event. The latter is one in which young and old are on a somewhat equal economic footing (although the older generation is still likely to hold more positions of power).

Not to mention the fact that having an elderly rentier class perverts macroeconomic policy in the service of voluntarily idle wealth just as much as having a rentier class in any other demographic.

So inequality between generations does matter at least as much as inequality between generations.

Sorry Noah I got to agree with Steve. This sounds like quibbling and not in a good cause.

Richard Ash: It may be true that inequality between countries is compressing while it's growing between countries. I notice that it's always apologists for inequality like Scott Sumner who want to make this point.

I mean is that supposed to make those of us who have been struggling over the last 10 years happy becasue the people in Asia and South America that have taken our jobs for a fraction of what we made are doing better? I don't feel bucked up.

The way Sumner tries to spin it, it's like we can't discuss inequality within countries because inequality between countries-may have-improved.

I agree with Noah: there are enough stats that point out with great clarity just how unequal the world is. We shouldn't have to come up with stats where the poorest persons aren't people starving in Africa, but medicine interns at some top notch hospital in the USA.

As far as I can tell, first world countries are currently experiencing rising inequality and secular stagnation. Third world countries enjoy stronger growth and declining inequality. The causation is running in both ways. Economic stagnation causes inequality, inequality causes economic stagnation.

The elite rentier / extraction operations by CEOs are still going on in third world countries, but the CEOs who are doing the extraction aren't local to those countries. So inequality is accelerating *even in third world countries*, but the "top side" of the inequality is "off the books" because those CEOs are offshore.

There are some exceptions: some third world countries with capital controls are *actually* reducing inequality.

Noah, I think you made a basic accounting error. You are saying some of the assets of the poor are being disguised by temporary debt, because the debt will eventually come off the ledger. And not accounting for that distorts the ratio. OK, but you are ignoring that as one cohorte of the poor are paying off their debt, the next is taking up debt.

OK Noah - you can quibble over the precise definitions and calculation. That quibble is a diversion from the real question of why there is this inequality and what the effect is.

I believe that the following two propositions are probably true:1) Outright fraud in China and Russia and widespread tax evasion/avoidance in the developed world are contributing significantly to the accumulation of wealth in the hands of a privileged minority. The founders of Google deserve to be wealthy but the tax planning strategies of Google should be outlawed. Bill Gates deserves to be wealthy but there is no way that Ann Romney deserves to have $100 Million in a tax sheltered IRA. 2) Many tax planning strategies are resulting in money being stranded in passive investments which are notionally offshore. Embezzlement in China and Russia has the same effect. When Google or Apple etc. (or a Chinese government official) takes profit from the American or European economies, avoids paying any tax and locks it into bank deposits or T-bills notionally held in a tax haven that flow of funds operates as a deflationary fiscal drag on the developed world's economies. There is a reason why the banks are holding two trillion dollars in excess reserves and there is a consequence.

Don't forget the defrauding of corporations by the corporate CEOs. Google's CEO isn't doing this, but most CEOs of big corporations, worldwide, are doing so. Writing themselves golden parachutes and multi-million dollar checks just because they *can* loot the company.

This accumulates vast amount of wealth in the clutches of a very small group of people, those who have weaseled their way into top executive positions.

There is a problem with the cohort argument. Isn't the measure of wealth based the whole household? How can the statistic be made by person? Other problem is that it takes more than a life to change your wealth with saving flows.

I really don't think PPP is an appropriate adjustment to make here, as big-ticket assets -- things that represent control over any significant fraction of the world's productive capacity -- are freely traded internationally at international prices. For local transactions and lifestyle, absolutely, but where it's an analysis of "who controls the world's economy", not so much.

[in fact, someone whose income comes in a higher-PPP-than-exchange-value ["undervalued"] currency has to get a higher income by their local standards than someone paid in a lower-PPP-than-exchange-value currency to acquire the same internationally-traded assets: if anything, the PPP correction needs to be reversed...]

What worries me about economics bloggers is that their posts are always a mix of data-driven empirical analysis and ideologically-motivated political drivel. The problem is most people cannot distinguish between the two most of the time, and no one can distinguish between the two all of the time.

This post is case in point. Here we've got Noah, a very data-driven econometrician and very intelligent individual, writing a post quibbling over numbers in a desperate attempt to get people to stop looking at income inequality. And the premise is absurd; even if you adjusted for age, the numbers wouldn't vary by more than 1000%. And if they did, as other posters have noted, it wouldn't make a difference.

Obviously, the attempt to get people to stop thinking about income inequality isn't working and won't work. The real disruptive trends of technology, the globalization of capital but the restriction of labor's free movement, and a massive, unsustainable explosion in population are all forcing all of us to think more seriously about the new economic reality of the 21st century.

I think the biggest problem with this statistic is that it is a misleading way of saying that the wealth of most people in the world is zero.

I can't find world statistics, but it appears that the next worth of about 18% of Americans is either zero or negative. Everyone above that line - each and every one of about 260 million people - "holds as much wealth as 50 million Americans!" Is that a particularly meaningful statement?

So, say I have a net worth of $10,000. This means I hold as much wealth as 50 million Americans. Does this imply that I have the same economic power, or political influence, or anything, as 50 million people?

"When we think of people with negative net worth, we imagine people drowning in medical debt or underwater mortgages or spiraling credit card bills - and of course there are lots of those people too. But many people borrow to invest, and that makes them look poor in terms of wealth, even when they aren't really poor.

You may ask: How big of a difference could that really make?"

And the answer to that question is "a good deal less than you would think."

Wealth disparities in nominal money or eligible collateral ("money wealth," if you will) matters - in some respect more than disparities in "real wealth." Partly because money wealth is intimately tied to political power - money is always, in extremis, backed by a man with a gun. And partly because extreme disparities of money wealth incentivize the holders of money wealth to push for deflationary policies (and they have more than their fair share of political power, for the above reason).

Deflationary and deflation-biased policies are highly destructive for the real economy. Both directly because inadequate inflation is destabilizing and indirectly because the policies which have a deflationary bias are almost universally bad policies.

Extreme disparities of money wealth furthermore suggests that the idle rentier class has been successfully perverting macroeconomic policy for some time, because prudent macroeconomic policy would have attenuated those imbalances before they grew to this magnitude.

(1) Adjusting for PPP is inappropriate, because those richest 85 people can buy goods and services anywhere in the world, including the cheapest places.

(2) Adjusting for age is another inappropriate irrelevance. If a small group of old people lord it over a large group of impoverished young people, that's just as bad as if a small group of young people lord it over a large group of impoverished old people. We're talking about 85 people here -- people who were rich when they were young, and who will be rich when they are old, and who will pass their money on to one or two children who will be rich when they are young.

Remember, we're talking about 85 people. 85 people who have too damn much wealth and need to have it taken away.

Things are precisely as bad as the Oxfam report says. The problem is that there are a very small number of people with far, far, far too much money. Wealth inequality is worse than you think it is, Noah.